Limitation of Liability Clauses: Review and Negotiate with AI

What is a Limitation of Liability Clause?

A Limitation of Liability clause sets a maximum amount that one party can recover from the other if something goes wrong. It's an important tool for managing risks in business agreements.

The main purpose of a Limitation of Liability clause is to:

• Cap potential damages
• Protect parties from excessive financial risks
• Help parties understand and assess their risks better

For example, in a deal between a manufacturer and a retailer for electronic devices, the clause might limit the manufacturer's liability to $1 million. This protects the manufacturer from huge losses while giving both parties a clear picture of their risks.

Where to Use Limitation of Liability Clauses

Limitation of Liability clauses are commonly used in various types of commercial agreements, including Master Services Agreements (MSAs), Software as a Service (SaaS) Terms of Service, Master Purchase Agreements, and Manufacturing and Supply Agreements (MAS).

These clauses are particularly important in agreements where there's a potential for significant financial risk. For instance, in a SaaS agreement, a Limitation of Liability clause can protect the service provider from excessive damages in case of a data breach or service outage. In a Manufacturing and Supply Agreement, it can limit a supplier's liability for defective products or delivery delays. In a Master Services Agreement, it can cap damages for both parties in case of project delays or quality issues.

Negotiating Limitation of Liability Clauses

When negotiating Limitation of Liability clauses, there are several key strategies to consider:

1. Aim for fairness: Try to make the limitation apply to both parties.
2. Consider exceptions: Some situations, like willful misconduct, gross negligence, or breaches of confidentiality might not be covered. For example, if a SaaS provider deliberately introduces a security vulnerability leading to a data breach, an exception would allow affected users to seek compensation beyond the standard liability cap.
3. Set the cap carefully: It could be a fixed amount or based on the contract's value. When negotiating, consider the potential risks and the value of the contract to determine an appropriate cap.
4. Be clear about special damages: Decide if indirect or consequential damages are included or excluded.
5. Know the rules: Some industries have specific regulations about these clauses.
6. Use clear language: Make sure the clause is easy to understand and consider including examples to illustrate how the limitation would apply in practice.
7. Think about other parts of the contract: Consider how this clause interacts with things like indemnification.

Remember, while negotiating Limitation of Liability clauses, it's crucial to balance risk management with fairness. A well-crafted clause can provide protection and certainty for both parties, fostering a more stable and predictable business relationship.

AI Contract Review for Negotiating Indemnification Clauses

To give you a sense of the benefits of leveraging AI Contract Review Software trained by lawyers, we’ve selected some sample language our software presents to customers during a review of Limitation of Liability Clauses in Master Service Agreements (MSAs). Keep in mind that these are static in this overview but dynamic in our software - meaning our AI identifies the key issues and proactively surfaces alerts based on importance level and position and provides suggested revisions that mimic the style of the contract and align with party names and defined terms.

If you’d like to see more, we invite you to book a demo.

‍Sample Clause for Customer Position

EXCEPT TO THE EXTENT LIABILITY ARISES FROM (A) THE INDEMNIFICATION AND DEFENSE OBLIGATIONS HEREIN AND (B) EITHER PARTY’S GROSS NEGLIGENCE, WILLFUL MISCONDUCT, OR VIOLATION OF LAW, IN NO EVENT SHALL EITHER PARTY BE LIABLE TO THE OTHER PARTY FOR SPECIAL, INCIDENTAL, CONSEQUENTIAL OR INDIRECT DAMAGES ARISING FROM OR IN RELATION TO THIS AGREEMENT OR ANY SOW UNDER ANY THEORY OF LIABILITY (WHETHER IN CONTRACT, TORT, NEGLIGENCE, STRICT LIABILITY, BY STATUTE OR OTHERWISE). THIS LIMITATION SHALL APPLY EVEN IF SUCH PARTY HAS BEEN ADVISED OR IS AWARE OF THE POSSIBILITY OF SUCH DAMAGES. LOSSES ATTRIBUTABLE TO BREACHES OF THE ARTICLES OF THIS AGREEMENT PERTAINING TO INTELLECTUAL PROPERTY RIGHTS, CONFIDENTIAL INFORMATION, AND PERSONAL INFORMATION ARE NOT SPECIAL, INCIDENTAL, CONSEQUENTIAL, OR INDIRECT DAMAGES WITHIN THE MEANING OF THIS ARTICLE. THE LIMITATIONS OF THIS ARTICLE SHALL APPLY TO THE MAXIMUM EXTENT PERMITTED BY APPLICABLE LAW, EVEN IF ANY REMEDY FAILS ITS ESSENTIAL PURPOSE.

Sample Guidance for Customer Position:

The MSA does not currently contain language addressing limitation of the parties' liability for special, incidental, consequential, or indirect damages. Without such language, the customer may be exposed to financial risk if its performance under the agreement causes the provider to suffer losses, such as lost profits, business interruption, or other economic harm.

To mitigate this risk, the customer may wish to negotiate the inclusion of a mutual limitation of liability article that expressly excludes the recovery of special, incidental, consequential, and indirect damages by either party. This type of article is common in MSAs and is generally considered a market-standard term. The likelihood of the provider suffering these types of damages will depend on the likelihood that the customer will be able to timely pay the provider.

Example Alerts That AI Contract Review May Flag for Customer:

• May be missing an article covering the limitation of liability under the Agreement and SOWs.
• May include language specifying that only the provider shall not be liable to the other party for special, incidental, consequential, or indirect damages arising from this agreement or any SOW. 
• May be missing language specifying that neither party shall be exempted from liability to each other for special, incidental, consequential, or indirect damages in the event that the liability is caused by such party's gross negligence.
• May be missing language specifying that the parties shall not be exempted from liability to each other for special, incidental, consequential, or indirect damages in the event that such liability is caused by such party's willful misconduct.
• May be missing language specifying that the parties shall not be exempted from liability to each other for special, incidental, consequential, or indirect damages in the event that such liability is caused by such party's violation of law.
• May be missing language specifying that the parties shall not be liable to each other for special, incidental, consequential, or indirect damages arising from this agreement or any SOW.
• May be missing language specifying that the parties shall not be liable to each other for special damages arising from this agreement or any SOW.
• May be missing language specifying that the parties shall not be liable to each other for incidental damages arising from this agreement or any SOW.
• May be missing language specifying that the parties shall not be liable to each other for indirect damages arising from this agreement or any SOW.
• May be missing language specifying that the parties shall not be liable to each other for consequential damages arising from this agreement or any SOW.
• May include language specifying that the maximum liability for provider stemming from an SOW or all aggregated claims shall not exceed the amounts specified in this agreement.

Sample Clause for Provider Position

IN NO EVENT SHALL EITHER PARTY BE LIABLE TO THE OTHER PARTY FOR SPECIAL, INCIDENTAL, CONSEQUENTIAL OR INDIRECT DAMAGES ARISING FROM OR IN RELATION TO THIS AGREEMENT OR ANY SOW UNDER ANY THEORY OF LIABILITY (WHETHER IN CONTRACT, TORT, NEGLIGENCE, STRICT LIABILITY, BY STATUTE OR OTHERWISE). THIS LIMITATION SHALL APPLY EVEN IF SUCH PARTY HAS BEEN ADVISED OR IS AWARE OF THE POSSIBILITY OF SUCH DAMAGES. THE MAXIMUM LIABILITY OF PROVIDER STEMMING FROM AN SOW HEREUNDER SHALL NOT EXCEED THE TOTAL VALUE OF SUCH SOW, AND THE AGGREGATE LIABILITY OF PROVIDER FOR ALL CLAIMS AND ACTIONS ARISING FROM OR RELATED TO THIS AGREEMENT SHALL UNDER NO CIRCUMSTANCES EXCEED [●●] IN TOTAL. THE LIMITATIONS OF THIS ARTICLE SHALL APPLY TO THE MAXIMUM EXTENT PERMITTED BY APPLICABLE LAW, EVEN IF ANY REMEDY FAILS ITS ESSENTIAL PURPOSE.

Sample Guidance for Provider Position

The MSA does not appear to include a provision addressing limitations on the types of damages that the parties can recover from each other in the event of a breach or other issue arising under the agreement or any related statement of work. Without such a provision, the provider may face significant risk exposure if the customer seeks to recover special, incidental, consequential or indirect damages.

It is fairly common in MSAs for the parties to mutually agree to waive claims against each other for these types of damages. The rationale is that the potential for unlimited liability on these types of hard-to-quantify damages could far exceed the value of the contract to the provider. While the likelihood of actually facing a claim for these damages may be relatively low, the financial impact could be severe if it did occur.

To mitigate this risk, consider negotiating a provision that expressly states that neither party will be liable to the other for any special, incidental, consequential or indirect damages arising out of or relating to the MSA or any SOW, regardless of the theory of liability. If the customer resists a complete waiver, potential compromises could include carving out exceptions for breaches of confidentiality, IP infringement, or gross negligence/willful misconduct or capping liability for these damages at some multiplier of the fees paid under the relevant SOW. Regardless, some limitation on these damages is advisable to reduce the provider's risk profile under the MSA.

‍Example Alerts That AI Contract Review May Flag for Provider:

• May be missing an article covering the limitation of liability under the Agreement and SOWs.
• May include language specifying that only customer shall not be liable to the other party for special, incidental, consequential, or indirect damages arising from this agreement or any SOW. 
• May be missing language specifying that the parties shall not be liable to each other for special, incidental, consequential, or indirect damages arising from this agreement or any SOW.
• May be missing language specifying that the parties shall not be liable to each other for special damages arising from this agreement or any SOW.
• May be missing language specifying that the parties shall not be liable to each other for incidental damages arising from this agreement or any SOW.
• May be missing language specifying that the parties shall not be liable to each other for indirect damages arising from this agreement or any SOW.
• May be missing language specifying that the parties shall not be liable to each other for consequential damages arising from this agreement or any SOW.
• May be missing language specifying that the maximum liability for provider stemming from an SOW shall not exceed the total value of such SOW and that the aggregate liability for all claims shall not exceed the amount specified in this agreement.
• May be missing language specifying that the limitations of liability in this agreement shall apply to the maximum extent permitted by applicable law, even in the event that a remedy fails its essential purpose.

Simplifying Your Limitation of Liability Clause Negotiations with AI

AI-powered tools like LegalOn can help legal teams:

1. Quickly spot important issues
2. Give alerts based on your situation
3. Suggest improvements
4. Ensure you're following relevant laws

The sample AI-powered insights we've shared demonstrate how LegalOn can enhance your contract review process, making it more efficient, thorough, and aligned with best practices.

To experience the power of AI in Limitation of Liability clause negotiations, we invite you to see it in action. Book a demo today to explore how our AI-powered contract review software can transform your approach to drafting and negotiating Limitation of Liability clauses.